Wage & Price Discovery

~ Jim Berger ~ Leave a comment

Socialists show reluctance to accept deferred payment or agree to absorb any losses. Even before they face those issues, how can they establish what portion of revenues they actually deserve? They cannot determine the price of the end product beforehand, and they cannot separate their real contribution to revenue. They have a real dilemma.

Value and Price of Product

Socialists don’t seem to understand that, even after having the capitalist subsidizes their wages during the production process, the market price for their wages remains unknown. The consumer has the final say on the price of the end product — the pencil. If the product sells for enough that the capitalist can replenish his subsistence fund and more, he will have profited from the risk he took. For the ongoing business, the replenishment of the subsistence fund allows the capitalist to repeat the process, which includes paying workers at every stage of production.

Yes, the capitalist does gain when he accurately estimates the price at which consumers will buy enough of the product to give him a profit. If, on the other hand, the market price — as established by consumers — does not replenish his subsistence fund. The capitalist will suffer a loss — even after workers have received their agreed upon wage.

Because consumers establish the value and price of products, it becomes impossible to, in any way, extrapolate the value of labor until after the sale of the product. Neither the capitalist nor the worker knows the market price of the product until after the sale.

A close up of a piece of paper Description automatically generated

Neither the value nor the price of any capital or labor involved in the production of the product in question can be determined until after a sale. Even then, the value of labor remains a subjective judgment on the parts of the capitalist on the one hand and the worker on the other hand. The capitalist prefers to pay as little as possible, and the worker prefers to get paid as much as possible. The actual wage — or price — results through the process of negotiation between the capitalist and the worker.

But, of all the ingredients that go into the production of a product, how can a person separate the value of labor alone?

Separating Price of Labor

If we assume that the product will sell for the same amount on the next cycle as it did the last, and we further assume the same amounts of capital and labor are used in the production on the next cycle, how can we extrapolate the proportion of that revenue that accrues to labor? If the socialists would only think about it, they would realize that we cannot determine the proportion that goes to labor.

As a socialist so readily point out, capital and labor must operate together to produce products. Either one without the other would produce nothing. Capital and labor represent two elements of a system — a system in which the whole produces more than the sum of the parts.

Because of the systemic nature of production, the contribution of the individual components cannot be determined separately. The person who contributes the most of the productivity of the manufacturing process is the person who designs the process, usually a person who is either a capitalist or works for a capitalist.

The Solution

Socialist face an economic dilemma. To achieve their ends of being paid “what they’re worth,” they must do all of the following:

  1. Defer payment and allow determination of wages until after consumers buy the product.
  2. Agreed to absorb a share of any losses incurred.
  3. Acknowledge that relative contribution to value is unknown and unknowable.
  4. Accept a negotiated wage after the fact.

In other words, for socialists to resolve the dilemmas created by socialism, they must become capitalists.

They should acknowledge the flaws in socialism and give it up as a failed system.

 

Socialism Would Pay Full Value

~ Jim Berger ~ Leave a comment

Socialists want full pay for their work. Would they delay that payment until completion of production? Would they agree to cover any losses after the sale of the product?

I recently view a video in which a student, who proudly identified himself as a socialist, confronted the speaker with the question: Why don’t workers receive payment equal to the full value of their labor contribution? Since capitalists cannot produce anything without labor, does it make sense that the capitalists should receive a premium — or a profit — above the value of labor? Shouldn’t workers receive the full value of their labor?

The question reveals ignorance on the part of questioner about how the system actually works. And, the speaker’s response, although accurate, did not answer the essence of the question.

I will fill in some of that gap.

Structure of Production

To fully understand why laborers do not receive a greater portion of the revenue received for the end product one must have a basic comprehension of the structure of production. The “structure of production” refers to the series of stages through which a product must pass before it becomes ready to offer to the final consumer.

Depending on the complexity of the final product that structure can extend backward through numerous stages and over a long time. The structure of production tends to exhibit far more complexity than most people expect. Whether by intent or not this conversation used pencils as an example, for Leonard E. Read wrote a marvelous piece titled “I, Pencil…” in which he described the complex process of bringing an everyday item like a pencil to market.

Capital Investment

Comprehending the structure of production sets the stage for answering the question about worker pay.

Before he can begin the lengthy process required to bring a pencil to market, the capitalist must find a source of capital— which means not money or machinery but necessary resources to sustain the production process until it can offer the product to consumers. Some use the term “subsistence fund” to refer to those resources. To accumulate a subsistence fund someone — the capitalist — must deny himself an amount of current consumption for some time.

Using money as a medium of indirect exchange, the capitalist will transfer portions of the subsistence fund to workers at each stage of production. The workers receive all of their agreed upon wages from the capitalist before he sells the first unit of product — in this case, the first pencil. Before that sale, the investment represents a total loss for the capitalist. The worker has lost nothing; whether satisfied with his wage or not.

Capital Loss

Socialists, demanding the “full value of their labor,” never offer to go without pay during the lengthy production process. Furthermore, they never offer to absorb any losses incurred from the business venture.

They want full value now.

But how does anyone determine that value? I will address that question in my next post.

 

Systems Thinking in Economics

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Systems Thinking helps people understand more clearly the complexity of markets.

You will probably hear me make several references to “systems thinking” in the process of explaining free markets. I thought that this post would be a good way to introduce systems thinking and its relevance to economics and free markets. To start off, I want to offer a concise definition of the system:

Definition

  • “A system is an entity which maintains its existence through the mutual interaction of its parts.” by the late Austrian Biologist Ludwig von Bertalanffy.

An accurate description of free markets fits perfectly with this definition. Markets become a unified system through the interaction of individuals making exchanges and not by an elaborate design imposed upon individuals.

As part of an introduction, I have borrowed “The Laws of the Fifth Discipline” from The Fifth Discipline by Peter Senge. I will give each of the eleven “laws” and provide my own description of how they apply to free markets.

  • “Today’s problems come from yesterday’s ‘solutions.’”

The presence of feedbacks represents one of the distinctive characteristics of systems. Many of the processes in systems create information that, when fed back into the system, change the input to the next iteration. Feedback becomes particularly crucial in human systems — i.e., systems that include humans as an element. For example, the system that includes both car and driver provides feedback to the driver so that he knows when to speed up, swerve, or brake.

The solutions that we apply to today’s problems simply shift the problem to a different time or space. The people who inherit the “new problem” frequently don’t recognize it as the return of an old problem.

This explains why many market interventions seem to address problems for which solutions have already been applied.

  • “The harder you push, the harder the system pushes back.”

Because systems contain “compensating feedback,” well-intentioned interventions frequently stimulate responses from the system that offset the benefits of the original interventions.

The higher lawmakers raise minimum wages, the higher the resulting unemployment.

The more lawmakers attempt to regulate segments of the market, the more frequent the occurrence of black markets or illegal activities.

  • “Behavior grows better before it grows worse.”

Any success at overcoming structural influence will only last for a short while. We find simple, “easy,” interventions enticing because they seem to work — in the short term. Then, again, compensating feedback takes over and things get even worse.

Economic stimulus gets people to spend more money. This causes a nominal increase in GDP. It also causes a lack of savings and investment resulting in a cutback in employment and reduced availability of goods in the future.

  • “The easy way out usually leads back in.”

Familiar solutions to apparently similar problems usually keep us mired in the same problem.

Adjusting tax rates to cure the “Social Security” problem eventually leads us back into the difficulty caused by the structure of this unsustainable “Ponzi” scheme.

Making significant structural changes to a poorly designed system will have more effect on eliminating recurring problems than making small changes to processes that only address symptoms.

  • “The cure can be worse than the disease.”

When we don’t account for the feedback from changes we make, we sometimes don’t see the full impact of our actions. Our central banking system increases the money supply to stimulate the seemingly slow economy. The misinformation sent by this artificial cure causes malinvestment, which leads to a depression worse than the apparent, but natural, slow down.

Sometimes the easy, familiar, solutions have no effect. Indeed, sometimes they become addictive and dangerous. By misguiding market players, monetary expansion creates an addictive dependence that eats away at healthy productive investment.

  • “Faster is slower.”

Remember the tortoise and the hare. Systems operate at the pace allowed by their structure. Pushing them too fast will cause delay or breakdown.

In our persistent efforts to create economic growth, we forget that the economy has a natural rate of growth. Rapid rates of business growth, brought on by market intervention, frequently outrun the capability of businesses to generate capital to support that growth. High rates of broader economic growth have the same effect. High rates of consumption eat away at capital growth, which slows future consumption.

  • “Cause and effect are not closely related in time and space.”

People intervening in market systems frequently commit the error of equating proximity of events with cause and effect. Human systems share the fundamental characteristic that cause and effect do not occur closely in time and space. We may not see the results of the actions we take today either in the same time or the same place. What appears like a sound expenditure now, may prove catastrophic when the effect finally reaches the market.

  • “Small changes can produce big results—but the areas of highest leverage are often least obvious.”

Chaos theoreticians speak of the “butterfly effect” in which a butterfly flaps its wings in some distant location causing a local storm in the future. Although this so-called “butterfly effect” serves mostly as a metaphor, it does give a sense of the importance of small events.

Frequently, the most obvious solutions either don’t work or make matters worse. Small, targeted, actions, however, can often produce significant and enduring changes. These high leverage actions do not seem apparent to the participants in the system. A one percentage point increase in the rate of saving might, through increased investment, improve long-term consumption by more than 15 percent.

  • “You can have your cake and eat it too—but not at once.”

Sometimes dilemmas only appear as opposing choices. For example, the false choice between “low cost” and “high-quality.” The short-term cost of higher quality may lead to both lower cost and higher quality in the long run.

The “low cost” bidding process employed by government frequently leads to the early crumbling of vital infrastructure.

  • “Dividing an elephant in half does not produce two elephants.”

As logical as it may seem, dividing a problem into smaller problems seldom works. If you have a big problem, you must treat it as such. You may have to take sequential steps to the solution, but you must coordinate these steps to solve the single problem.

The integrated, holistic, nature of living systems requires that they must remain intact to realize their full benefit. The whole equals more than the sum of its parts.

Governments build their reputations on promising half an elephant as if it were one elephant. Treating government spending and taxation as independent issues amounts to dividing the government interventionist elephant.

  • “There is no blame.”

We tend to blame outside influences. “Systems thinking shows us that there is no outside; that you and the cause of your problems are part of a single system. The cure lies in your relationship with your ‘enemy.’” (Senge page 67.) Don’t blame the people when they do the best they can within the system in which they operate.

When you encounter a surly government employee, remember they work for a system that does not recognize you as the customer. They owe their allegiance to other bureaucrats and politicians, not to you. You have no influence on a system that you do not pay directly.

Conclusion

Many the characteristics of systems seem counterintuitive, until you think about them. Human systems, such as markets, add a higher level of complexity. These systems reflect on the results of their own behavior and adjusted their behavior to achieve different results. In other words, they learn.

Interventionists simply cannot outsmart markets.

Reference

Senge, Peter M., The Fifth Discipline (New York: Doubleday), 1990

 

Disrupting the Money Cycle

~ Jim Berger ~ Leave a comment

Artificial changes in the money supply always disrupt the money cycle and cause price disruptions that lead to production problems in otherwise normally functioning markets.

Introduction

The complexity of large markets makes the diagramming of market processes difficult at best. One must take great care in not overstepping the bounds of logic and systems thinking.

However, occasionally a small diagram can at least trigger questions that need to be asked about the system under discussion. In this article, I will discuss an extremely simple — possibly overly simple — diagram depicting the cycle of money in two markets.

First, I will describe the cycle of money in a free and voluntary market without monetary intervention.

Second, I will give a brief description of the market subject to monetary intervention.

My objective consists of getting you to ask more pertinent questions regarding assumptions about monetary expansion, used by the Federal Reserve system and strongly advocated by the modern monetary theorists.

Free Market

The ridiculously simple diagram that I have provided below should open your thinking to questions about the operation of a free and voluntary market.

In this diagram, I have represented three producers/consumers named Eddy, Joe, and Max. I think you can see already that this does not accurately portray the immense complexity of any market. But, bear with me, and I think this diagram will help me make a significant point.

I have identified the steps in this process by the circled numerals.

  1. Eddy, also the producer of Good1, finds what I refer to as Good0. (The quantity of this Good found by Eddy represents all that exists in the system.) This Good will, in this diagram, come to be accepted as a form of money—a medium of indirect exchange. I have used dollar signs to indicate money, but dynamics applies to any form of money.
  2. Eddy exchanges his newfound money with Joe for Good2, produced by Joe. Eddy consumes all of the Good2 that he has acquired. The cycle can repeat through time as long as Joe produces more Good2 in Eddy as a source for money. I will explain how Eddy gets money in the next few steps.
  3. Joe uses the money that he received in the exchange with Eddy for Good3 produced by Max. Joe consumes all of the Good3 that he acquires. Max now has money that he can use for exchange.
  4. Max exchanges his newly acquired money for Good1, produced by Eddy. Eddy now has money he can use to repeat the cycle, returning to step 2).

This diagram provides a terribly oversimplified model of the daisy chain of events that make up a market system. A real market will consist of billions of the exchanges similar to those depicted in this diagram, all connected in very complex ways.

Despite the oversimplification of the system depicted in this diagram, each individual transaction works precisely the same as a transaction in the real market. One person exchanges money for a Good he values more than the money he gives up. These individual exchanges provide the foundation of a complex system that provides effective price discovery and efficient resource allocation.

Two essential things happen during this cycle. First, the fixed quantity of money, first found by Eddy, has served for three transactions. The system has required no additional money. Second, each transaction has produced an objective money price — the ratio of money given to goods received. This money price will serve to inform the allocation of resources in future cycles.

For the sake of this example, each person in these exchanges requires the Good that he receives for his subsistence. If he does not receive that good, he will perish.

Monetary Intervention

I have modified the diagram given in the free-market example to demonstrate the effects of monetary intervention. The steps are very much the same as in the first example with one significant difference in step one.

  1. Instead of finding a Good that he can use as money, the government gives Eddy the money he needs to purchase the goods he requires. Eddy produces nothing. (Create your own reason why Eddy produces nothing to trade. Maybe he likes being on the dole.)
  2. Eddy makes the same exchange with Joe and consumes the Good that he receives.
  3. Joe makes the same exchange described above with Max and also consumes all of the Good that he receives.

Max now has all the money he requires to buy Good1 that he requires for subsistence. But, no one in this system now produces Good1 and Max perishes.

With the absence of Max, no Good3 exists to provide subsistence for Joe, who also perishes. With the demise of Joe, Eddy gets no Good2, and he also perishes.

Thus, with the injection of new money into the system, for the purpose of keeping it going, the process has reversed itself and the system has died.

Conclusion

I’m sure that you can see that I have left a number of factors out of this discussion to make it as simple as possible. For example, I have not addressed the effect of rising money prices caused by the addition of new money. And, I have not taken this example to any level of reasonable complexity.

I have created this example the sole purpose of raising one fundamental question: what happens when no one produces any Good to acquire the money that enters the system—regardless of source?

Very complex systems, unlike my oversimplified example, can absorb a large quantity of artificially created money before this question becomes significant. But, at some point, the system responds to this unanswered question.

In the case of the real estate crash that occurred in 2008, it had taken from 45 to 50 years for the money artificially funneled into real estate to wreak havoc on the market. The advocates of MMT want to create a perpetual hole in the production cycle through the artificial expansion of money that they propose.

Watch out for the free lunch. It could cost you everything.

 

The Dangers of Modern Monetary Theory

~ Jim Berger ~ Leave a comment

At the core of Modern Monetary Theory (MMT) lies the implicit premise that the acquisition of money represents an end of itself. MMT bases its argument on what some people refer to as a “missing premise.” They present a proposition that contains an unstated premise that they assume everyone accepts. Give people more money, created out of nothing, and their spending will increase economic activity.

Although this premise seems quite appealing to many people, it contains a flaw that invalidates the entire theory.

Introduction

I first encountered MMT several years ago on one of the social media platforms. The people involved seemed almost fanatical about the idea, but I found it lacking logical consistency. For that reason, I thought the whole idea would die a natural death.

Recently, almost by accident, I have encountered several new references to MMT. This seeming resurgence may have occurred because one of the economic advisors for Bernie Sanders strongly advocates for MMT. In addition, I think that the rise in popularity in socialist ideas has given new vigor the conversation about MMT. People seem to like the idea — advocated by MMT — that you can receive things at no cost, e.g., medical care, schooling, retirement, etc.

I hope to point out, in this post, some of the weaknesses in the argument for MMT. To accomplish this, I would like to address just a few basic premises that the advocates of MMT either ignore or misunderstand.

  • They seem ignorant of the role of money as a medium of indirect exchange.
  • Demand does not exist in the aggregate or without the prior production of goods.
  • Double entry bookkeeping proves nothing about the results of expanding the money supply.

I cannot make exhaustive comments in the space that I have allotted myself. I only want to open your thought to some of the unanswered questions left by advocates of MMT.

The Role of Money

If you consult almost any textbook on economic theory, the author will describe money as a “medium of exchange.” This phrase, although accurate, does not explicitly portray the real role of money. Money actually acts as a medium of indirect exchange. Ignoring the importance of this fact brings MMT to its knees (as it does any theory about monetary manipulation adhered to by the Federal Reserve).

Any good that somebody exchanges for another good acts as a medium of exchange. The important distinction comes in identifying mediums of indirect exchange. With an indirect exchange, one party accepts a good for the purpose of exchanging it a second time for yet another good. That good has little or no value to them without the possibility of exchanging it for the third good. A medium of indirect exchange simply facilitates an otherwise goods-for-goods exchange. One must understand this distinction to comprehend the role of money clearly.

The single role of money consists of its use as a medium of indirect exchange. Unlike other goods, it never gets exchanged for the purpose of consumption. For that reason, the system requires no change in the quantity of money. It only requires, to accommodate declining money prices, that whatever good (or claim on that good) used for money can be divided almost indefinitely. The government or the banking system need not increase the quantity of money—for any reason.

In a market system, with goods prices based on money, the relationship of the goods-for-goods prices become distorted when the quantity of money changes arbitrarily. This price distortion forms the basis for economic malinvestment and boom and bust cycles, which wreak significant havoc on economic activity.

MMT (along with the Federal Reserve) ignore the critical importance of the real role of money. The ignorant use of monetary expansion leads to the economic boom and bust cycles addressed by the Austrian Business Cycle Theory.

Aggregate Demand

MMT relies to a significant degree on the concept of “aggregate demand.” This idea, popularized by John Maynard Keynes, claims that the government should stimulate an economy by doing something to increase aggregate demand. The idea of aggregate demand, however, represents a pure fantasy.

First, demand cannot exist without prior production. In the goods-for-goods exchanges facilitated by media of indirect exchange, some good must be given up in the acquisition of money. Without that good being given up, a reduction in the overall goods and services occurs. With the introduction of artificially created money, some traders find they have exchanged something for nothing. (For more insight, refer to “Increasing Demand Won’t Make the Economy Grow” by Frank Shostak.)

Providing money for nothing means that eventually, some buyer discovers that sufficient goods do not exist to complete transactions. But, we cannot know specifically what goods the economy lacks. Which leads to the second problem with aggregate demand.

Second, one cannot aggregate, or sum, the demand for a multitude of separate goods. You cannot add five chickens, two iPads, four Chevy Volts, etc. and derive a meaningful total. Summing the dollars exchanged in an economy gives no real information about the sum and substance of the goods exchanged.

Double Entry Bookkeeping

MMT advocates make a big deal about the importance of double entry bookkeeping and balance sheets. One person’s spending does indeed represent another person’s income. This tautological statement proves nothing regarding the validity of the argument for expanding the money supply to “stimulate demand.” It only means that in a double entry bookkeeping system debits and credits must always equal.

Since the entries in bookkeeping systems reflect quantities of money (both debits and credits), this only means that when somebody gives up money for a particular good, they record (as a debit) the amount of money given up. They do not record the quantity, or the characteristics, of the thing acquired.

Remember that money denominated double entry bookkeeping does not reveal what goods, if any, were given up to acquire that money. Although the books may balance, if the money used in the underlying transaction has been created ex nihilo (out of nothing), the transaction represents a fraud somewhere in the system.

Conclusion

The increasing popularity the socialism, and socialist politicians, leads me to believe that MMT presents a real danger. The danger lies in its appeal to people’s desire to get something for nothing. Socialism by itself cannot allocate economic resources effectively and efficiently. The implementation of what I would describe as a “free money policy” would only add to the misallocation of resources caused by the administration of a socialist system.

People need to learn the valid propositions behind sound money. We live in an environment in which people accept monetary expansion as a natural phenomenon. Artificial monetary expansion represents a stealthy form of violent intervention—it dilutes the purchasing power of personal property. Despite the problems with our current monetary system (also based monetary expansion), the system could be worse. The implementation of monetary policy based on Modern Monetary Theory would undoubtedly be worse than what we already have.

 

Linguistic Revision

~ Jim Berger ~ Leave a comment

The language used by economists confuses many people—including themselves. Imprecise usage of words and phrases leads to poor communication and flawed thinking. Test the meaning of everything you hear or read about economics and free markets.

I have lifted the title of this post from the title of a chapter in Science and Sanity by Alfred Korzybski. Korzybski deserves credit for establishing the discipline referred to as General Semantics. I may refer to General Semantics in future posts. General Semantics might be described as a discipline that studies the effect of language on human behavior. Korzybski talks about how changes in language can change people’s behavior and some parts of our language require change in order to stimulate new and more effective the behavior.

Korzybski refers to three important thinkers who have influenced our thinking through the ages and continue to today: Aristotle, Euclid, and Newton. The words that we use to describe the thinking of these three mental giants tend to lead us to linear, cause-and-effect, thinking. Korzybski advocates that based on the new knowledge about our world that we need to shift our language to reflect non-Aristotelian, non-Euclidean, and non-Newtonian, thinking. We now live in a world in which A is not always A, straight lines only exist in concept, and gravity no longer acts instantaneously over distance.

The language used in economics and the description of free markets still reflects the old linear, cause-and-effect, thinking. We need to learn how to use language more accurately in order to reflect the reality of the human systems we call markets.

Out of the many words used in economic lexicon I have chosen four to demonstrate how their usage can frequently confuse people’s understanding.

Value

Readers of my blog know that I make frequent references to value. I do so because it lies at the core of economic thinking.

Commonly economists refer to value as something that a person can measure, record, and calculate. The scientific use of value coincides with this meaning.

Economics, however, refers to human systems in which the word value takes on an entirely different meaning. In that context it becomes a subjective judgment limited to the mind of the individual. We cannot measure or calculate value. We can only measure human action based on value.

Demand

The word demand, in popular usage, has several different meanings. Economists make that meaning only slightly more precise, and in some cases totally confusing. In many cases they give the impression that the existence of more people creates more demand. They also described demand as something that can be plotted on a diagram to which suppliers will respond.

Demand only exists when a person brings something of value (to the other party) and offers it in exchange. Without something to exchange demand cannot exist. In addition, the notion that demand can be plotted ex-ante is almost ridiculous. Ask two people who just completed an exchange what the demand curve looked like before they made the exchange.

Aggregate

The word aggregate frequently appears in economic writing and conversation. Frequently economists refer to aggregate demand, aggregate income, or aggregate employment. The term conveys the underlying assumption that these generalized concepts can be summed in some meaningful way.

Summing individual demand, individual income, or individual employment, amounts to a mathematical or logical impossibility. The idea that we can add these things defies logic and insults the importance of individual responsibility and decision.

Inflation

If you look up the term “inflation” in an economics textbook or dictionary, you will usually find it defined as a general rise in prices. When economists start discussing the causes of these general rises in prices, they refer to things like wage inflation, consumer price inflation, or other types of price inflation.

A rise in the general price level (meaning a generalized increase in the prices of individual products) can, in fact, occur. But, the cause has only a single source: monetary expansion. Without an expansion of the money supply, when the price of one good goes up, the price of some other good or goods must go down.

Rising prices caused by monetary expansion create a distortion in the information flow transmitted by the mechanism of prices.

Interest

The concept of interest confuses a lot of people, including those involved in financial transactions. The traditional concept of interest relies on the relative productivity of capital. The productivity of capital does have an influence, but this really confuses the issue. It makes it a little hard to explain interest charged for the purchase of consumer items.

A simpler and more straightforward explanation of interest deals with time preferences. A good in the present always has more value than the very same good in the future. Thus, in order to entice a person to exchange a current good for a future good, a greater quantity of the future good must be offered. Interest consists of the difference between the amount of the current good and the amount of the future good in an exchange.

The reader should note that the amount of interest, and the interest rate, depend on the two independent variables involved in the exchange. No one can change interest rates independent of those two variables. The Fed, for example, cannot control interest rates.

Conclusion

Practitioners of the hard science have the luxury of creating new language to describe their principles and theories. After all, who do cosmologists speak to other than other cosmologists. Economists, on the other hand, do not have that luxury. They talk to other humans about human activities. Yet, they need to promote certain level of precision in the language they use.

When you listen to, or read, the words of an economist take care not to interpret what they say based on the normal meaning of those words. Do they give the same meaning to these words that you do? And, possibly more importantly, do they introduce a certain level of inconsistency into their own thinking by using the common meaning of the words?

I can’t expect to cause linguistic revision just by pointing out a few words that I call into question. But I would hope to encourage readers to question the words that people use in describing free markets. Do they really mean what you think they mean? Do they really make sense?

 

In closing, consider these two phrases:

Innocent until proven guilty.
Innocent unless proven guilty.

Which words would you use?

 

National Debt Burden

~ Jim Berger ~ Leave a comment

Pundits, inside and outside of government, make a big deal out of the problems of national debt. Before you understand the problem of national debt you must understand the truth behind what they say about national debt.

Having the federal government borrow money to finance its operation does not really amount to the large problem some people believe. The real problem consists of the misallocation of resources caused by government “spending.” Government borrowing simply provides another way of financing the misallocation. The real risk from government debt comes from the effect that it has on financial markets, not the impact that it has on the economy.

Who Really Pays

Many people claim that national debt creates a burden for “our children.” As long as we have a progressive tax system, “our children” will never bear a large portion of the current tax burden nor will they bear the burden of government debt.

When the time comes to pay national debt — if that ever occurs — it will be the children of rich people, or new rich people, who bear that burden. We can’t understand how big a problem national debt will cause until we understand exactly who pays it and what happens to the money in the interim.

Occasionally a person will claim that government debt does not represent a problem because we “owe the money to ourselves.” The problem, as I mentioned in my opening, does not consist of who owes money to whom but the deleterious effect of resource allocation through government “spending.”

Government finance consists of a very complex subject. A person can never achieve a real understanding of the problems and its ramifications.

Walk with me through three diagrams that I hope will give you a handle on why government debt by itself does not represent a large problem.

Government Finance Without Borrowing

The diagram below represents a very simple model of how government finance should work. In order to pay for its outlays government must collect taxes. In this example, they collect an equal amount from Taxpayers A and B, and they collect next to nothing from Taxpayers C. Those taxes represent the bulk of government receipts with which it pays its outlays. (To simplify this model, I have left out other forms of government revenue — park fees, license fees, etc.)

Also, forgive me for using the word “outlays” instead of the commonly used word “spending.” For me the word “spending” connotes exchanging something for value. Most of what government calls “spending” consists of redistribution; so, it doesn’t deserve to be described as “spending.”

Machine generated alternative text: Taxpayers A Taxpayers C Go vernm ent Taxes Taxpay ers B G overnment Outlays Outlays Beget Taxation Government Rec eipts

You can see from this very simple example that government taxes finance all government outlays. For the purpose of these examples, I make no argument about the validity or you effectiveness of the government outlays.

In the next model I will show how government uses borrowing to finance some of its outlays.

Government Finance Including Borrowing

Government must always receive enough money to equal its outlays. When it doesn’t receive enough in tax revenues, it must borrow the balance. The diagram below depicts that process in a relatively simple form.

As in the previous diagram Taxpayers A and B split nearly the entire tax burden between the two groups, and Taxpayers C contribute next to nothing. In this case, however, Taxpayers A and B play different roles. Taxpayers A, mostly entrepreneurs, invest most of their income into various investments. Taxpayers B invest most of their money in government bonds.

Thus, Taxpayers B provide all the money the government borrows. This allows Taxpayers A to delay their tax burden for an undetermined time. Because of this tax deferral, Taxpayers A have more money to reinvest than they would have if government had collected enough tax revenue from A and B to cover its outlays.

This process has the effect of temporarily transferring the liability of Taxpayers A to Taxpayers B. Does this mean that the children of Taxpayers A face an additional tax burden in the future? Yes. But, some benefits accrue to the errors of Taxpayers A. Government acts, in effect, as an intermediary for a low interest loan from B to A.

I will attempt to demonstrate this in hypothetical example below.

The Real Effects of Government Borrowing

The diagram below represents a hypothetical situation in which, instead of lending money to the government, Taxpayers be lend the same amount of money directly to Taxpayers A — with a guarantee from the government.

This diagram, of course, does not represent how government financing actually works, but it does represent the real effects of government borrowing.

Machine generated alternative text: Government D ebt repayment Outlays Taxpayers C Government Taxes Outlays beget Taxation Taxpayers A Taxpayers B Taxpayer A's Debt Taxpayers A B orrow Government Rec eipts

[I think you can see that I could’ve made a simpler diagram. I left this diagram in the same format as the previous diagram so you could see the effects of simply substituting “Taxpayers A Borrow” for “Government Borrows.”]

In this case, Taxpayers A receive what amounts to a low interest loan from the Taxpayers B, at a preferred interest rate. Of course, Taxpayers A will eventually need to repay the debt, but, in the interim, they receive a return on the money they don’t pay in taxes and can invest.

If the financing arrangement were done according to this hypothetical example, no one would complain about the burden imposed on future generations. People see a big problem, however, if when government achieves the same results by doing the borrowing itself.

Foreign Lenders

I have not discussed the influence of foreign lenders to our government. That process can become very complicated depending on how foreign banks deal with that money. If, for example, they expand their own money supply in order to acquire US dollars, that will hold down the price of US imports giving a benefit to US consumers, and causing inflation in their own country.

Investment Risk

So, why should we consider government debt a problem?

The biggest risk of massive government debt arises in the financial markets. When government debt rises to the point where investors doubt that the government can raise enough tax revenue, the price of those bonds will decline significantly causing disruption to financial markets. That disruption can feedback into the “real” economy.

Conclusion

I have attempted to explain a very complex issue with a few words and diagrams. But, above all else, I want you to comprehend that complexity.

When someone tells you that the rising federal debt represents a huge problem, and a huge burden for “our children,” remember the complexity of the process. Don’t consider the results all good, all bad, are all benign. You need to know who’s paying the taxes, who’s getting a tax deferral as a result of government borrowing, what they’re doing with that deferred tax revenue, and what effects it has outside this simple example.

The real problems arise from the redistribution resulting from government “spending.”

Healthcare Economics

~ Jim Berger ~ Leave a comment

Government involvement in “healthcare” provides startling example of an incredible waste of resources that no one seems to notice. It shows how a current benefit causes a long-term drag on the economy.

In my last post I pointed out how a vote for government amounts to a vote for economic inefficiency.

In this post I will point out some important questions regarding a specific intervention of government in the market — the intervention in “healthcare.”

The complexity of this subject precludes me from covering it in any detail. I would simply like to point out some of the issues that people seem to ignore when dealing with the subject.

Terminology

How can we discuss the subject intelligently without using accurate terminology?

We have for years used the euphemistic term “healthcare” to refer to what should more accurately be referred to as “sickness-care.” In common usage, people normally use the term healthcare to refer to prescription drugs, hospital stays, vaccinations, etc. These topics, however, have a great deal to do with sickness and very little to do with health.

Most people also seem to deny that this sickness-care is a product or service that should have a normal market price. Some people claim that they have a right to healthcare. By some magical activity it should be given to them with no cost. They don’t seem to understand that healthcare consists of a service like many other services—not much different from the service of a plumber or an auto mechanic. Natural law gives you the right to life. It does not give you the right to health; that’s up to you.

To prevent confusion on your part I will continue to refer to sickness-care as healthcare. I don’t want you tripping over too many new concepts all at once.

Prices-Costs

Price plays an important role in the allocation of all resources—even those used in a service like healthcare. But, what mechanism tells bureaucrats what to pay providers for medical treatment services? They have no way to effectively and efficiently allocate resources to such a valuable service because they have no price mechanism to observe. If they want a resource, they give up nothing to get it—unlike a consumer would.

The willingness of people to pay for healthcare should determine the price of medical care in the same way that people’s willingness to pay for gasoline determines its price. How much do you value your own health? What sacrifice would you make to maintain good health?

The government does not — indeed cannot — know the answers to these questions. And, providing the service free, or cheap, creates another set of problems.

Demand

Economists don’t agree on very much, but they nearly universally agree that providing a good for free, or cheap, leads to more demand.

More demand almost always leads to higher prices for the entity paying the bills. When government takes on the role of providing any service for people, the price, ultimately paid by taxpayers, tends to rise. Look at the many activities in which government intervenes e.g. schools, union wages, postal service, real estate, etc. The prices rise faster than the rest of the market. The same thing happens to the cost of healthcare.

With free healthcare people tend to have more doctor visits, more visits to the ER, and more demand for prescription drugs. Since government does not know the value of any of these services, they have no way of knowing how much to provide nor at what cost.

Allocation

Ever-growing demand with the lack of an effective pricing mechanism leads to an inefficient allocation of medical resources. As with most government activities, providing healthcare amounts to a redistribution from the healthy and productive to the sick and less productive. This redistribution causes a drag on rest of the economy that affects all consumers. Without these pricing mechanisms, how can bureaucrats know who should get what treatment and when?

This principle—mis-allocation due to lack of price signals—applies particularly to what has become a political talking point: pre-existing conditions. Who defines the meaning of pre-existing conditions and determines who has them? Then, who pays for the treatment of those pre-existing conditions. As indicated above the healthy and more productive people pay for the sick and less productive.

The resources taken involuntarily from productive activities actually create a negative feedback for the sick themselves. The long-term source of the philanthropic support of those with serious conditions gets diminished by current taxation and transfers to the ill.

Enough resources do exist to help those who really need long-term financial assistance for their medical needs. Individuals, however, not the government should decide from where those resources come. The government, by confiscating people’s resources, insult the voluntary kindness of people and their willingness to help people in need. People with pre-existing conditions would not die in the streets without government stealing on their behalf.

Conclusion

Healthcare, like any other service, should be left to the participants in the market. Consumers should decide how much they value their own health, and generous individuals can and will help who need long-term medical care.

Government intervention in healthcare leads to at least three detrimental outcomes:

  • Higher costs—paid by tax payers.
  • Misallocation of resources—robbing more productive people.
  • A general drag on the economy—costing the healthy and sick alike.

Will legislators ever have the political courage to take the right and effective action and get government entirely out of the business of providing healthcare?

 

Election Day

~ Jim Berger ~ 1 Comment

Your vote today supports theft, tyranny, and disaster.

When you cast your vote today, think about what you have really done. You have really abdicated your responsibility for your life, liberty, and happiness, in favor of authorizing theft, tyranny, and disaster. You probably feel like you’ve done the responsible thing. Your friends, family, the Hollywood elite, and the news media, all tell you so. But you need to use language that accurately describes the economic result of a vote in what people erroneously refer to as a democracy.

When political power overruns an economic system, voters should describe it in language that accurately describes what voters have done.

Theft

Voters have been led to believe that they do the right thing for our citizens when they vote for a system that offers healthcare, Social Security, welfare, and infrastructure. These all seem like things from which citizens can benefit. This may be true, but voters need to consider what they give up for these benefits.

Government “spending” creates a mis-allocation of precious resources. Government does not bear the cost of its “spending,” as do individual consumers. It engages in theft, which we refer to as taxation, in order to redistribute other people’s resources.

Would you steal from your neighbor in order to pay for something you want? Then why authorize politicians to steal in your name — even for a good cause?

Tyranny

Most of us want to improve public safety, assure that citizens deal with each other fairly, protect public health, and protect the environment. But, do political means implement the best processes to achieve these objectives?

What we refer to as “regulations” really amount to tyranny and oppression. Voters engage the monopoly force of government to restrict the behavior of other people. They violate the rights of citizens by restricting their use of their own property.

Disaster

Most citizens desire a healthy and growing economy — one that supports sufficient jobs and income for people to live comfortably. They have grown to believe that rising prices are a sign of a healthy and growing economy. If the banking system must expand the money supply to accomplish this objective, voters do not object.

Economists and politicians refer to monetary expansion as a form of economic stimulus. Monetary expansion, however, disrupts the market’s healthy pricing mechanism. The misinformation created causes artificial booms, which invariably lead to economic disaster. Along the way many of the rich get richer — but not in a healthy way. They don’t make more money by providing more and better products for consumers, they do so in trading with the artificially expanded money supply.

Conclusion

Whatever your political philosophy, voting supports the economics of oppression. It legitimizes the system in which the monopoly power of government intervenes in the normally efficient operation of markets.

  • Government engages in theft in order to redistribute resources according to the preferences of politicians.
  • Government engages in tyranny by influencing people’s behavior through the threat of violent force.
  • Government sets up the economy for future disaster through artificial stimulation resulting from the expansion of the money supply.

Election day provides an opportunity for you to consider the negative influences of the political means on your economic well-being. The words theft, tyranny, and disaster evoke a different emotional response than the terms spending, regulation, and stimulus. But, shouldn’t voters use words that more accurately describe for what they’re vote.

Take the opportunity to learn why markets unfettered by violent intervention—Free Markets—will always provide more effective and efficient allocation of resources.

Free markets bear a similarity to life — difficult; but rewarding.

 

Nations Cannot Win or Lose Trade Wars

~ Jim Berger ~ Leave a comment

Nation-states have no resources of their own. They redistribute the resources of their citizens. Nation-states can neither win nor lose when they play with other people’s resources. Tariffs and other weapons of trade wars disrupt normal trade; helping one group at the expense of another.

Illusion of Trade Deficits

The concept of trade wars begins with the illusion of trade deficits. When looking at the economy as a whole, trade deficits simply cannot exist. An economy, as a single unit, does not exist. An economy consists as a network of individual transactions. Thus, any comments about “an economy” require that we look at the nature of those individual transactions.

When a consumer acquires any good or service, by voluntary means, he always gives something in exchange — something he values less than what he gets. Thus, because the parties to an exchange leave with more value than they enter, no deficit can exist in any individual transaction. To make an hypothetical accumulation of all consumer transactions in an economic system the same logic must apply.

Buyers will always give money for the products they buy, whether from a local supplier or from a supplier in another country. Consequently, no deficit exists.

What Happens to the Money?

If a buyer always pays money for goods that he receives from overseas, what happens to that money?

One of three different things can happen to that money:

  • That money pays for products from the country of origin. Those purchases count as exports from the country of origin and thereby reduce the trade “deficit.”
  • That money acquires investments in the country of origin. Those investments, although not included in the GDP, have future benefit for that country.
  • That money buys government debt, which provides money for government giveaways. Those giveaways add to consumption and thereby the GDP. Not a bad thing from the policy-makers’ perspective.

How Do Tariffs Help Nation States Win War?

Only nation-states engage in “trade wars.” Peaceful traders have no incentive to engage in unhealthy activities.

The people involved in actual exchange do so voluntarily and peacefully. If they don’t like the terms of the exchange, they either renegotiate or abandon the transaction.

Since nation-states have no resources of their own, their actions — either through trade restrictions or tariffs — simply redistribute the resources of their own citizens. Nation-states have no weapons of their own for the conduct of trade wars; thus, they have no way of either winning or losing.

Trade Wars Cause Economic Disruption

The trade wars between nation-states disrupt the economies that they profess to help. In an effort to assist one part of the economy they always cause disruptions in other parts of the economy. The policies used in “trade wars” ignore the complexity of the markets with which they deal. For every player their policies help, multiple parties get hurt.

A couple of diagrams will give a very simple idea of the disruption caused by trade wars using tariffs.

Before Tariffs

This first diagram shows the situation before the implementation of tariffs. The consumer buys good G from supplier F (a foreign supplier) instead of buying the same good from supplier A (an American supplier) because it costs less money.

With the money the consumer saves he can buy products from other suppliers. The money earned by those other suppliers can, in turn, buy additional goods from an undetermined number of other suppliers (depicted by the cloud at the bottom).

The consumer gets more benefit and part of that benefit gets passed on to the rest of the economy.

After Tariffs

After the imposition of a tariff, which makes the price of good G from supplier F higher than the price from supplier A, the consumer will have to pay a higher price for the same product. This causes a chain reaction of negative results.

The consumer no longer has the extra money saved. He reduces his spending with other suppliers. The revenue of these other suppliers declines, and they spend less money with their suppliers. An indeterminate number of people in the economy get hurt as a result of the imposition of tariffs.

Please keep in mind the extreme complexity of international trade. A small intervention at one point in the trade process will have effects that ripple throughout the national economy and the international economy. We have no way of measuring the effect of these interventions. Because they always cause a disruption the normal trade process, these interventions will always have negative consequences.

Conclusion

Nation-states can gain only one thing by engaging in trade wars: political power. Some politicians think they are doing good things for their constituents by engaging in trade restrictions and tariffs. They base the activities of “trade war” on the false premise that trade deficits actually exist and they must be cured.

International markets, just like to domestic markets, are entirely too complex to be effectively managed. Messing with otherwise free markets only causes damage to the participants. In particular, it causes damage to those the politicians have sworn to protect.